This article explores some of the differences between commercial LDI and new home building warranties and how to avoid claims. It also looks at current market appetite for these products and why this matters to the build-to-rent market.
What is latent defects insurance, and how does it differ from building warranties?
Latent defects insurance (LDI) protects property developers or owners against damage resulting from defects in design, materials, or construction that only become apparent after completion.
LDI can normally only be purchased if an insurer’s engineer carries out a technical audit throughout the construction phase. Once they have signed off on the project’s construction, cover can be arranged from the date of practical completion for a period of 10 to 12 years. The insured can be any party with an insurable interest in the project, and policies can be assigned to the new owners if a development is sold. Tenants can also be included as insured parties.
New home building warranties provide broadly similar cover, but are mainly used for new homes and are required by mortgage lenders before approving a loan. A separate certificate will be issued for each dwelling within a development and the cover is for the benefit of the home owner.
Whilst the construction insurance market in general has hardened significantly in the past 24 to 30 months, the market for latent defects insurance has remained fairly stable from a premium rating perspective, with some new capacity emerging.
Common claims and how to avoid them
There’s a whole range of latent defects that can lead to structural damage which only becomes apparent after a project’s completion. This can land property owners with very significant costs unless LDI cover has been arranged. One common example occurs where properties have been built on inadequate foundations, resulting in subsidence. The cause could be any combination of poor design, poor workmanship or poorly specified materials.
Not only will an LDI policy cover such eventualities, but simply having an insurer’s technical auditor involved during the construction process reduces the risk of latent defects. A comprehensive inspection of the foundations during the construction phase provides peace of mind for the building owner and insurer, but also helps identify any risks relating to materials, workmanship or design, which can then be rectified before construction proceeds.
Another common cause of LDI claims is ingress of water. This could involve water getting in through the cladding of a commercial building or through a leaky roof in a private residential property. Again, the insurance engineer provides a valuable second pair of eyes. For the auditor to sign the property off for LDI, its waterproof membrane will need to have met Building Control installation standards and been designed by a competent professional. An LDI policy normally covers damage resulting from water ingress from 12 months after practical completion until expiry.
What is insurer appetite for LDI like?
The commercial latent defects insurance market is dominated by a small number of lead insurers. These include Aviva, HDI and Castel Underwriting Agencies (on behalf of SCOR), with support from other insurers like Swiss Re and Munich Re. One of the main reasons for the limited number of insurers involved in this class is the length of time insurers are on cover without the ability to amend annual premiums, as they could with some other types of construction policy, if a claim were to arise or if the market hardened significantly.
For larger residential developments or commercial projects in particular, insurers will request a substantial amount of information from the proposer before issuing formal terms. This means underwriters have to spend a fair amount of time reviewing these details. Depending on the nature of the project, they may wish to add certain exclusions and conditions to the policy.
It is important to arrange an LDI policy before commencing a project or development. This enables the insurer’s engineer to review the design specifications and to get a better understanding of the scheme as they carry out the essential technical audits throughout the project’s lifetime. Arranging a policy once a development has commenced will be more challenging, as this falls outside insurers’ normal appetite. If an insurer is willing to provide cover, the premiums are likely to be much higher and the request for information is likely to be even more onerous than usual.
LDI in the build-to-rent market
The build-to-rent (BTR) sector has grown significantly over the past couple of years, and is expected to continue growing for the foreseeable future. According to Savills, BTR stock in the UK now stands at 70,785 completed homes, with 42,100 more under construction. Beyond that, there are another 99,300 homes in the pipeline, including those currently in the pre-application stage. In other words, there are more than 200,000 BTR homes completed or in development.
One of the big questions around insurance cover for BTR schemes is whether the asset will be retained and whether all units within a development will remain as rental units. As soon as project owners or developers look to sell units to new homeowners, they could run into issues with the practical saleability of their units without having new home warranties in place. If there’s a possibility their properties will be sold anytime during the 10-year period after practical completion, owners or developers need to engage with a warranty provider before construction commences.
As mentioned above, LDI policies should be placed before construction starts, so that insurers can carry out their full technical audit throughout the construction period. Though it may still be possible to procure LDI cover after construction begins, insurers are uncomfortable about doing this, and will want to charge more. How much more will depend on how far works have progressed. Underwriters will also be likely to insist on certain exclusions.
If a BTR development has been completed with the last ten years, and the intention is to sell off units individually, any purchasers will need approval from their mortgage providers. In most cases, lenders will not approve funding in the absence of a new home warranty. If a buyer can’t get their mortgage approved, clearly, the developer can’t make that sale. This underlines the importance of sound long-term planning where BTR developments are concerned.
BTR is now a mature and stable asset class, however. So, if there are no plans to sell within the foreseeable future (i.e. within the next decade), a commercial LDI policy may provide a more suitable option for building owners and funders.
For more information, please get in touch with a Lockton service team member.